2018 Elections: A Long Night for the Republicans

Although my forecast for this Tuesday's elections is uncomfortably close to the consensus of the pundit class, I really do believe that the Democrats will do quite well and that the Republicans, especially those in the House and the state houses, will be crying in their beer. Given how strong the economy has been, by rights the Republicans should be cruising toward a huge victory, but this year it is certainly NOT "the economy stupid," it is instead "Trump, stupid."

On a seat by seat basis I have the Dems picking up 32 seats, but because most of the excitement is on their side, I think the Dem gains will be on the order of 35-40 seats. In the state houses the Republicans are going to take a licking with the Dems picking up 7-8 governorships. More than a few of those gains will be in historically Republican states. 

In contrast the biggest Republican margins will be in very blue Maryland and Massachusetts where the incumbents are extraordinarily popular and I wouldn't rule out a Republican pickup in the very blue and very ill-governed state of Connecticut. The sweetest Democratic pickup will likely be in the very Republican state of Kansas where the anti-immigrant xenophobe Kris Kobach will go down to defeat.

The Senate will be a different story. The Dems face a horrible map and in that body the Republicans figure to pick up one or two seats. There are too many Senate elections in the margin of error so the range of outcomes here is quite large.

As they say in poker, "read em and weep."

My Amazon Review of Alan Greenspan's and Adrian Wooldridge's "Capitalism in America: A History"

The Building of America

Former Fed chairman Alan Greenspan and Economist editor Adrian Wooldridge have written a long needed upbeat history of capitalism in America. It is a history of creative destruction that glorifies the spirit of enterprise that built our country from 13 struggling colonies to a continent spanning behemoth. The authors glorify the exploits of Thomas Edison, John Deere, Bill Gates, Samuel Morse and Henry Ford.

Of course all of this did not happen in a vacuum. America is blessed with a temperate climate, fertile soil, navigable waterways and enormous mineral deposits. Perhaps more important our nation was born when enlightenment values were beginning to flower. As a result we ended up with a constitution that limited government and protected property rights that allowed enterprise to flourish.

The villains of the piece are trade unions and a political/intellectual elite who would rather substitute their judgement for that of the markets. Although the authors do discuss the origins of the 2008 financial crisis, they underestimate the role of financial markets in undermining the very economy Greenspan and Wooldridge are extolling. Hence the need for a modicum of regulation. Moreover the authors ignore the political corruption that ran rampant during the Gilded Age, the 1920s and our era of today.

Although the authors through many barbs at government, in reality they are Hamiltonian conservatives in that they favor broad based policies to support the economy. Those included support for the railroads, the Homestead Act, and land grant colleges all of which played a role in the great explosion of growth in the post-Civil War era.

The authors end their book on sour note fearing that the growing burden of regulation and entitlement costs will sap the dynamism of the economy going forward. I believe that is a necessary condition, but it is not sufficient to restore capitalism’s dynamism. What is needed are huge investments in basic research, education and infrastructure and that means more, not less government.

I would note that this book is nowhere near as detailed as Robert Gordon’s “The Rise and Fall of American Growth,” but it is shorter and an easier read and it is an antidote to the anti-capitalist screed of Richard White’s “The Republic for which it Stands"

The full Amazon review appears at: https://www.amazon.com/review/RPCTI0AOP2XWV/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Steven R. Weisman's "The Chosen Wars: How Judaism Became an American Religion"

Becoming at Home in the New Promised Land

Former New York Times journalist Steven Weisman tells the story of how Judaism became Americanized largely through the lens of the disputes between the reformers and the traditionalists coming of age in the America of the 1800s. Much of the arguments then echo true through today as to the role of women, music, choirs, English versus Hebrew in services, peoplehood versus religion, the difference between awaiting a Messiah or Messianic Age, and the relative importance of prayer and study versus social action.

Much of his history takes place in Charleston, South Carolina, which in the 1820s had the largest Jewish community in America. In fact the struggle over an organ became so heated that it had to be settled in court. What interested me the most was that much of the arguments in South Carolina preceded the arrival of the mass immigration of German Jews in the 1840s and 50s who later became the back bone of Reform Judaism. And because there were so many Jews in the South, the Jewish community split over the issue of slavery with Judah P. Benjamin becoming the Confederacy’s secretary of state. Nevertheless when Lincoln died much of American Jewry viewed him as the second Moses.

Wiesman’s book is the history of the rise of the Reform movement and the traditionalist reaction against it against the backdrop of an America that was much different from Europe. To the reformers the synagogue was the new Temple and America was the New Jerusalem. Thus there was no need to pray for a rebuilding of the ancient temple and much of the ancient rules seemed out of place in the hustle and bustle to de Tocqueville’s America, especially on the frontier.

In America there was no formal rabbinic authority. In fact there were no Rabbis until the 1830s and no American ordained rabbis until the 1880s. As a result authority was vested in the individual congregations which meant that much of the argument took place among the laity. To be sure there were leading rabbis like Isaac Wise and Jacob Leeser, but they too were responsible to their congregations.

My problems with Weisman’s book are that it over emphasizes the intellectual divisions over the role of spirituality and over emphasizes social justice politics over a connection with G-d. In many respects religion represents the triumph of faith over reason. To be sure social justice is important, but Weisman’s definition is probably far from my own because it is my belief that much of the success that Jews have enjoyed in America has come not from political action, but rather from the blessings of the market economy. Thus, unfortunately there is some truth to the old joke that Reform Judaism is the Democratic Party with holidays. To be sure Jews should be “the light among nations,” but we should walk the walk with a great deal of humility. That said Weisman has given us a well-researched book on how the Jewish religion adapted and became of age in the new Promised Land.

For the full Amazon URL see: https://www.amazon.com/review/R16Z2C7OL6XBK3/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

Bank OZK: A Canary in the Commercial Real Estate Coal Mine?

Bank OZK, formerly Bank of the Ozarks surprised the market today by reporting a 439% increase in loan loss provisions to $42 million over the year ago quarter. The stock is down 9+ points today to 25, half of its 52 week high of 51. 

Why is this important to commercial real estate? Over the past few years this once obscure Arkansas bank has plunged into construction and development lending in such non-Arkansas locales as New York City, Miami and Los Angeles. Those three cities account for half of the bank's $12 billion loan book. For many small and mid-size developers Bank OZK has become the go to lender for C&D loans and therein lies the problem. In order 
to gain market share they had to be aggressive with respect to price and terms.

To be sure half the increase in the loan loss provisions was due to two loans originally made in 2007 and 2008 one for an enclosed mall in South Carolina and the other for a residential land development project in North Carolina. Nevertheless absent those two projects, the loans loss provision in quarter would have almost tripled versus a year ago.

My guess is that if we are in the early phases of a commercial real estate decline, future commentators will note that Bank OZK gave the market a fair warning of what was to come.

My Amazon Review of Howard Marks' "Mastering the Market Cycle: Getting the Odds on Your Side"

Understanding Cycles

Howard Marks of the very successful Oaktree Capital Management has written a way too long and very repetitive book on understanding market cycles. Where was his editor when we needed him/her? Nevertheless his “Mastering the Market Cycle” is an important book that will give disciplined investors great insight. Discipline is the operative word, because without it Marks’ insights are of limited value.

Marks cites five critical cycles: 1) economic, 2) profits, 3) stock market 4) credit and 5) risk. An investor has to know where we are with respect to each of those cycles and most important is the risk cycle which is determined by the psychology of investors. Simply put are they greedy or are they fearful. Although this sounds easy in theory it is very difficult to implement. For example it is very hard to be bearish when the whole world is bullish, this I know from experience, and conversely it is even harder to be bullish when the whole world is bearish. It is at the extremes where the most money is to be made and where discipline is most needed.

The problem with implementing Marks’ ideas is that it is difficult to know how long a cycle will go on. Marks’ cites Greenspan’s famous “irrational exuberance speech of late 1996, only to witness the late 90s bull market to roar on for another three years. Although Marks was brilliant in backing up the truck in the credit markets at the height of the Lehman crisis in 2008, even he admits it was a close run thing and his success was dependent upon the efforts of Paulson, Bernanke and Geithner in stemming its worst effects.

Putting Marks’ ideas to use today I find that the current economic upswing is much closer to the end than the beginning, profit growth is certainly peaking, the credit market is wide open to most borrowers on very favorable terms and aside from the past few days in early October most investors remain bullish after a ten year bull market that quadrupled the major stock market indices, and investors seem oblivious to global macro and political risks. Thus the way I read Marks it is at least time to be cautious and consequently a time to de-risk portfolios.

Making one last point, I wish Marks cited the late Hyman Minsky who noted that stability leads to instability and although he didn’t directly state the converse, instability leads to stability. That would be Marks in a nutshell. Although too long and too repetitive “Mastering the Market Cycle” is worth the read. There is much wisdom here.

For the full Amazon URL see: https://www.amazon.com/review/R2WH5246HCRNPE/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Ben Macintyre's "The Spy and the Traitor: The Greatest Espionage Story of the Cold War"

Mrs. Thatcher’s Spy

It is not for nothing that John Le Carre noted in a front cover blurb “the best true spy story I have ever read.” Ben Macintyre’s biography of KGB Colonel and MI6 spy Oleg Gordievsky reads like a novel. His description of Gordievsky’s exfiltration from Moscow by MI6 under the watchful eyes of the KGB has all the hallmarks of a tension-packed Hollywood spy drama and that alone is worth the price of the book.

The story begins with Gordievsky growing up as the son of a KGB general who becomes disillusioned with life under Soviet communism. He follows in his father’s footsteps and is recruited by the KGB. He is initially stationed in Denmark and there he is willingly recruited by MI6.  As he rises in the KGB bureaucracy he become ever more important to the British. Along the way he marries, divorces remarries and has two daughters.

Where Gordievsky enters history is when he becomes a senior political officer in the KGB’s London rezindentura in the early 1980s. While there he reports to his MI6 handlers that the Soviets actually believed that the United States was going to launch a first strike on the Soviet Union. So paranoid is KGB head and future general secretary Yuri Andropov that he sets up Operation RYaN to find evidence of plans for a first strike. As in most bureaucracies the KGB spies produce such evidence thereby exacerbating his paranoia. The same thing happened with the CIA when it was ordered to look for weapons of mass destruction in Iraq twenty years later.

Compounding the problem was that at about the same time in 1983 NATO ordered up its massive Able Archer exercise which was a practice drill to deter a Soviet invasion of Western Europe. To the Russians it looked like a precursor to war. It was Gordievsky who tells the British of the Russian fears who then relay that information to the CIA. Several authors have noted that had not both sides deescalated, nuclear war was on the table. Gordievsky’s information to both Thatcher and Reagan was influential in bringing about from the de-escalation.

As the Soviet heir apparent, Gorbachev met with Margaret Thatcher in London in 1984. Here Gordievsky’s role is crucial because be briefed both Thatcher and Gorbachev as MI6 spy and KGB political officer on negotiating strategy. The meeting was a big success and Thatcher noted that Gorbachev was a man she could do business with. The end of the Cold War was now more than a pipe dream. Later, after his exfiltration, Gordievsky meets with Reagan to advise him on negotiating strategy for an upcoming meeting with Gorbachev.

But wait, what caused Gordievsky to be exfiltrated from Moscow, especially after he was made the Rezident of the KGB’s London office? In very short form the CIA is jealous of MI6 and wants to know who their source is. They soon find out and his name ends up on the desk of Aldrich Ames who was selling secrets to KGB officers in Washington. His betrayal leads to the death of scores of CIA operatives and sources in Russia and ultimately to the KGB investigation of Gordievsky. In Macintyre’s view Ames is a traitor who sold out his country for big bucks and Gordievsky is an honorable spy seeking to better his country.

This is a great book that I couldn’t put down and I highly recommend it. As an added plus you learn quite a bit of trade craft.

For the full Amazon URL see: https://www.amazon.com/review/R1DYCZTEAIL4ZH/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Ray Dalio's "Big Debt Crises"

The Pathology of Debt Crises

Ray Dalio runs the very successful $150 billion Bridgewater Associates hedge fund and he is more than qualified to understand the pathology of debt. His book offers up a template for understanding of how a debt crisis develops where early optimism leads to over-leveraging that can longer be serviced which leads to analyzing the appropriate policy responses to it and a great deal of pain for society as a whole. He also fully understands that once a crisis is in full train there can be very negative political feedbacks that can make things far worse.

To Dalio policy makers have to ignore, at least initially, the problem of moral hazard. That is bailing out the ones who were in up to their eyeballs in making the crisis. He was fully supportive of the banker bailout program which in his opinion and my opinion was necessary to save the system. Where I would differ is that once a crisis has past the critical phase, those responsible have to be held to account. One of the reasons why there is so much populism on the right and the left is that no major banker in the U.S. went to jail. That was unlike the savings and loan scandals of the late 1980s and the dot.com frauds of the late 1990s. Our pagan society needs ritual sacrifices to cleanse the system.

Where his book is most valuable is his discussion of the three major debt crises of the past 100 years:  Wiemar Germany 1918-24, the Great Depression 1928-1937 and the recent Great Financial Crisis of 2007-2011. He goes through each of those crises in great detail and in many cases on a nearly day-by-day basis. In the case of the recent crisis he includes his contemporaneous Bridgewater Daily Observations publication to get his thinking in real time. By doing this he puts you into the shoes of investors and policy makers as they scramble to make sense as to what is going on. In the case of the German hyper-inflation he notes that given all of the constraints that might have been the least bad alternative policy to follow.

Dalio credits the work of Bernanke, Paulson and Geithner in preventing the U.S. in falling into a second great depression after the failure of Lehman Brothers. However letting Lehman go in hindsight looks like a big mistake. However as I have written elsewhere letting Lehman go was analogous to killing the chicken to scare the monkey. He also credits the smooth hand-off between the Bush and Obama administrations which contrasted to the lack of a hand-off between Hoover and Roosevelt in 1933.

I have several quibbles with the book. In the Wiemar inflation he rightly notes that the assassination of highly respected finance minister Walter Rathenau made it more difficult for Germany to renegotiate reparations payments, but he ignores the untimely death of foreign minister Gustav Stressemann in 1929 who might have been able to ease Germany’s external debt problem. He further ignores the untimely death of New York Fed president Benjamin Strong in 1928, who in Milton Freidman’s view might have saved the U.S. from the worst of the depression. Dalio, although he mentions it, under-rates the Treasury’s gold sterilization policy in the mid-1930s that triggered the 1937 relapse into depression.

Dalio also ignores the role of Bridgewater during the crisis. After all Bridgewater was part of the problem in that it was very likely they were shorting mortgages, high yield debt, equities, and bank stocks while being long treasuries, the U.S. dollar and gold. How else could Bridgewater have made money in 2008? Lastly the book is too long, but read the three case studies with great care which are magnificent.

The full amazon URL appears at: https://www.amazon.com/review/R14MDUVXEYA262/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv